The theme for our last summer Fajanza® was “Here’s to 2010”. Well, here we are at the eve of the new year and that sentiment is felt by many. While the year was marked by geopolitical issues from Somalia and Zimbabwe to Iraq and Iran, everyone in the US seemed to focus on the economy as it (hopefully) found its nadir and then steadily recovered. Looking at the recession to date, it looks like we felt a dip and largely recovered.

But the real impact is more easily seen if we look at a ten-year period. With this view we see why we’ll be telling our grandchildren about 2009.

For those of us working with start-ups, the economy didn’t just make world affairs less important but made it hard to notice anything beyond concerns like making the next payroll. I don’t know what kind of data we’ll eventually see but it was a rough year for start-ups. Venture funding of new companies nearly collapsed as VCs decided which of their investments were worth keeping and which should die. The former required more insider financial support as they were unable to sell, go public, or even take down funding from new investors at a reasonable value. The latter died. Angel investors faced much of the same situation although they don’t have investment committees that judge winners and losers. Angels are typically more loyal and optimistic and most sought to continue support of their entire portfolio if it seemed there was reasonable hope for success or achievement of the next milestone.

We saw three venture investments in 2009: Microgreen (Waste Management and WRF); Inlustra (Samsung); and Gist (Foundry). Three gems, frankly, in the pile of coal from which Santa picks for stocking stuffers for VCs who CEOs would judge a little too naughty for anything this year.

For employees, it was a time many of us have never experienced. Nearly everyone had a friend or relative out of work. Some, heavily invested in real estate and stretched with large mortgages, faced fiscal calamity.

Early-stage companies felt the end of growth more than lay-offs. For companies with 5-10 employees, there wasn’t much room to cut and we only saw job cuts at two of our 40+ active companies. But the growth ended. Few start ups grew in 2009.

We can talk about investors and we can feel the impact as employees but what about those who really drive the economy? No, I’m not talking about Madoff or Bernake, I’m talking about the start-up economy so I mean the entrepreneurs.

I’m reminded of my favorite Christmas story. It was on December 23rd, in 1944. A US armored division was retreating from the Germans in the Ardennes forest when a sergeant in a tank destroyer spotted an American digging a foxhole. The GI, PFC Martin, of the 325th Glider Infantry Regiment (my old unit), looked up and asked, “Are you looking for a safe place?” “Yeah” answered the tanker. “Well, buddy,” he drawled, “just pull your vehicle behind me…I’m the 82nd Airborne, and this is as far as the bastards are going.”

Look again at the charts above. It was in this economy that Marketfish launched, that Meteor transformed its business model with a successful new offering, that Liquid Planner showed breakthrough growth. In the summer of 2009, Limeade was offering its wellness solution to customers as it started to grow sales and Zooppa successfully launched in a new country. I could go on.

The boldness, the confidence, to use a popular term – the audacity of these entrepreneurs to start something new and to persevere in the worst economic climate most of us have ever known is beyond inspiring. Technology entrepreneurs are the foundation for economic growth in this country and they defy the odds with each venture. They set an example for all to follow in 2009 as they grew revenues (every company in our portfolio that had revenues in early 2009 ended at a higher rate) and payroll (overall, our portfolio showed payroll growth of about 10% for the year).

The entrepreneurs certainly were aware of the economic climate. But instead of retreating, they dug in, worked harder and applied themselves to win. I couldn’t be more proud of our CEOs and what they’ve accomplished.

The recession has brought out the worst and the best in us. We’ve felt the sting of failed commitments, been saddened by selfishness, and been frustrated by short-sightedness. Relations, both business and personal have been strained. But it has also been a time of courage, of loyalty and of faith. I’ve never felt so immersed in the camaraderie of entrepreneurship and, as unpleasant as it’s been, many of us will come out of this refreshed and better for the experience. You’re a special breed and you don’t hear nearly enough appreciation for what you do.

Here’s to 2010. It will be better and many of you who stood up to the overwhelming economic dangers will be proven to be heroes in your own way. I’m proud to be associated with you.

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When we read business plans, we find that most entrepreneurs tell us how they’re going to scale to their mature size. The plans focus on the channel sales, the viral growth or some other aspect of sales that is highly scalable and compelling.

But why do some startups get initial traction while others don’t seem to get off the ground? Because some CEOs embrace one vital reality: the way you sell today won’t be the way you sell tomorrow.

Your business plan is great and your sales strategy is exciting. But if you don’t start selling now with different (typically lower) expectations and (typically less interesting) methods, you won’t get the initial traction you need. Your plan may talk about how you grow from $1MM to $100MM in revenue but that’s not necessarily how you’ll grow from zero to $1MM (of course these numbers vary). Let’s talk about what’s different and why.

Size of the deal. Your initial sales will be smaller than the sales you hope to have eventually. There are several reasons and this could be our most important point:

Sales cycles are proportional to deal size and you need to close business now. Closing business sooner will make fund-raising easier, will bring in cash, and will get users sooner. Getting users sooner means that you’ll more quickly learn what you did wrong in building the product and what needs to get fixed in your customer support.

Your product or service quality will get better over time so don’t sell to a company-maker (i.e. the “big customer”) now. You’re going to have problems with both the product and how it’s supported. Let a less-important customer experience these issues and work with you to improve them.

Your deal terms will be flawed. Even with all the smarts that the best contracts attorney can offer, you’re still going to miss something. Maybe you’ll get deal terms wrong by insisting on something you later learn doesn’t matter at all. Maybe you’ll omit an important protection. You won’t get it right the first time. Make mistakes on smaller deals and perfect your deal terms by the time it really matters.

Your pricing will be wrong, possibly both in structure (e.g. subscription vs one-time sale or pricing mix of core product vs the disposable portion) and price. Make these mistakes on lower-revenue deals as you learn how to optimize revenues and margins.

You simply won’t be successful because larger buyers will more likely demand reference accounts to demonstrate the product or service works as advertised.

Together, we call this the Stair-step approach to enterprise sales. You want to sell to the great customer to the far right. Most (not all) startups that try to start there fail. Most who embrace the stair-step are able to get the initial traction they need to climb the steps.

Margins. Margins will improve over time. Ok, this is obvious but most entrepreneurs don’t act accordingly. Too many entrepreneurs pass up early opportunities because they’re unattractive. But they often fail to factor in the value of closing the business – a reference account, a customer who will help you improve the offering, and increased investor interest (yes, investors are smart enough to understand the concept of margin improvement). If your first potential deal is a relatively small opportunity, worry more about getting it done and less about the margins on it. This is, of course different for a company that’s selling to a finite number of potential customers (e.g. a product sold to US auto manufacturers or cell phone manufacturers) or if you’re working a real opportunity to sell to a large player early in your company’s life.

Channels. Your business plan might call for others to sell your product but don’t count on that initially. While the effort of channel partners varies greatly from just “order takers” (think retail) to proactive sales groups that will energetically sell because they make their money on installation and support (think software system integrators), very few channel partners will close business for a product that has not had a customer before. Note that I don’t say few channel partners will sign on to sell your product – they’ll do that. But signing and actually selling is the difference between your college buddy who says he’s there for you and the when he actually shows up on the day you’re moving with his truck. We wasted a fair amount of time with Meteor, trying to get ad agencies (they barely get a passing grade as channel partners) to resell the product until we realized that we had to close business first. Once we showed good traction, they engaged.

Marketing-driven sales. Most consumer web deals and many other products focus on marketing-driven sales. Your plan shows that viral growth or marketing spend will drive traffic with good scale effects. Nearly all successful companies in your space probably grew this way. But few obtained their initial users this way. A great example for us was Findood. This market maker (grocery store buyers connecting to food manufacturers) had a plan that was based on marketing to bring both parties to the web site. But the marketing budget needed to get this started was impractical for the startup. So we picked up the phone. We called on both sides of the market to seed the site with a critical mass of buyers and sellers. To make the marketspace more attractive, we focused our efforts on a sub-market (chocolate in this case) to yield better concentration for our efforts.

Of course there are stories of companies which had great success at very early stages and you should explore these bigger, better deals on a parallel path. But understand they probably won’t close soon; don’t bet the business on having an extraordinary success early-on. Focus on Plan B with smaller deals on less attractive terms. You’ll get customers, you’ll get investors, you’ll perfect your product or service, and you’ll avoid the fatigue of a startup that just can’t quite seem to get it going.

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So often, when we talk about the terms of an agreement that one of our portfolio company is negotiating, we hear advice that just isn’t helpful. There are plenty of unfavorable terms that startups must accept in their early agreements. It’s just the reality of being the smaller party with little history, credibility, or alternatives. My points below assume that this is your first or one of your first big deals. It could be a direct sale or a distribution agreement. These points also assume you’re an early-stage company with a minimal (say $20k to $200k/yr) legal budget. And, while we’ve certainly seen our share of fair-play and reasonable partners, I’m assuming the worst (we’ve seen that too) will come out from your much-larger customer or business partner.

We’ve negotiated many deals on behalf of our companies with bigger players like Microsoft, Standard & Poors, or General Mills. Many of these deals were company-makers for our fledging startup while they barely mattered to the other side. So, what can you do when you have no leverage but need the deal?

Focus on the LOI. Get all the deal terms that matter to you in the letter of intent. It needn’t be a document you’ll sign (it needn’t be binding) but you discuss the terms here. Once the LOI is done, you’ll find that negotiating omitted terms will take much longer and these discussions will be more costly and probably harder for you to get what you need.

Save attorneys fees. Let Bigco do the drafting. Paying your counsel to review is cheaper than drafting. If you have gone through this and have a standard agreement you like, then use it. You can plug in Bigco’s name and pricing by yourself and have your counsel review any material changes.

Venue and choice of law for dispute resolution. Forget about it. Bigco has a standard for this and unless you’re dealing with an overseas entity, it’s just not worth the fight. Give it up but…

Arbitration. This can work either way but I believe that, in general, arbitration favors the startup. If Bigco ends up being evil and disputes are to be resolved through the courts, then they can tie you up and quickly exhaust your miniscule legal budget. They may also seek an injunction. Even if their accusations have little truth, you may be unable to afford a defense. Binding arbitration is typically a little gentler and less painful to you if Bigco lacks a valid case. We usually ask for terms whereby the loser pays all costs of both parties in the arbitration. We don’t try to write the arbitration clause; instead, we ask if they have an arbitration clause they can insert in lieu of other remedies. We’re successful with this about half the time. If they tell you that they have a corporate policy that forbids arbitration, see my point on Venue, above.

Term and termination. Let’s face it: if Bigco wants out of the agreement, they’ll likely get out. They may just stop paying, stop re-selling, or stop supporting or stop using your product. One way or another, you should assume that the fact that your contract is still active won’t be enough to compel a larger partner to continue to honor the agreement. Sure, you might have grounds to sue but look again at your legal budget. Now, if the deal turns out to be sweet for them and takes advantage of your startup the situation will be different. You can expect Bigco to enforce the agreement. Shorter terms and easier outs benefit the smaller company. Note that you might have a work-around to this problem if you can negotiate the ability to raise prices with moderate notice (you could raise prices to an untenable point as a means to force a termination). And as for termination, contracts are often written to allow for termination either on n days’ notice (often 30 or 90) or to allow for termination within n days of the anniversary (otherwise, they renew for another year or more). You’ll want language that allows you to start the termination clock at any time, not just during a window prior to the anniversary date.

Exclusivity. Brrrrrr – just hearing the “E” word sends shivers, doesn’t it? The reality is that many exclusivity deals are far less worrisome than they may appear. First, exclusivity need always be described with these (maybe others as well) parameters:

Geography. Usually a sales territory. Can be defined at the customer’s headquarters.

Time. How many months or years is the deal exclusive?

Products. Be sure to note that the deal isn’t necessarily exclusive to all products and address derivative or ancillary products. Your exclusive agreement may allow you to provide free demo products by disallowing any “sales”.

Customers. You can often carve out listed customers or groups of customers.

Applications. Your partner may be interested in only certain applications of your product.

Channel. You may be able to continue to sell directly, while giving limited exclusivity for resales.

Performance. Probably the most important aspect and it’s often overlooked. If you’re granting an exclusive for distribution, ask Bigco for their volume estimates. Then add a performance requirement to their exclusivity such that they must pay you x% (maybe 70% or so) of the estimate in order to continue to retain the exclusive.

A great example of exclusivity came at Connected Systems. When I got there, the CEO had negotiated a deal with our launch customer. That customer agreed to pay most of the NRE to develop our core product and in exchange we agreed not to sell production volumes (it allowed demonstration sales) to any company for a year. The sales cycle in this industry was about nine months. By the time we had a concept we could demo and a salesteam to show it, the year didn’t matter.

Assignment. This varies a good deal in each situation. In general, Bigco won’t care much about whether they can assign the agreement to an acquirer if they sell, so if you care, they might agree not to assign without your agreement or that they cannot assign to a certain list of potential buyers or those in a given industry. Bigco will, however, care if you can assign and they’ll normally say that you cannot without their approval. The most significant issue here is the potential automatic assignment to your acquirer. You’ll want to avoid that. You may sell to Bigco’s competitor and that buyer won’t want to be forced to provide product or services to their competition. If you’re unable to get your deal signed without such automatic assignment, you should try to get a buy-out or a time limit associated with it.

IP Ownership. The term you care about here is “derivative works” and this is a tough one. Who will own the intellectual property associated with modifications made to your product. If your distributor or customer gains ownership in these, it can be disastrous. The circumstances vary widely here. In many cases, you’ll be able to own the IP. If you cannot, spend some time on this by really thinking through the likely outcomes.

Use of their name. You’ll probably want to list them as a customer. We’ve often found that Bigco doesn’t like this however, we have routinely been able to get an exception that allows us to disclose the relationship to existing or potential investors.

Payment terms. Be mindful of the logistics and admin you’re getting into with regard to payment terms. With many reseller agreements, it’s just not worth it to create monthly payments and quarterly payments will make more sense. Payments should be made within, say, 15 days of the end of the period and should be accompanied by a report that describes the activity and the calculation.

Audit. If the payments made to you are based on activity by Bigco, then it’s reasonable to have a right to audit their reporting. Usually, this right is limited to once a year (unless you’ve discovered an error in that year) and is performed by a third party. Bigco should be liable for any under-payments you find, sometimes with fines or interest and if the underpayment is large (maybe 5% or so) or intentional, then they should pay for the audit as well. This might all sound overly paranoid but these terms are fairly common.

Lastly, of course, these contracts are vital legal documents. Get qualified help from counsel. A solid CFO can lead the negotiations and help with much of this but don’t sign a document like this without an attorney’s review.

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To most entrepreneurs, human resources means pay and benefits and only the basics at that. There’s a lot to be gained by embracing a full spectrum of HR but, for now, let’s go deeper on pay and talk about a Comp Plan.

A Comp Plan proactively adds some structure to the way we pay people. If we do it right, we add just enough structure to get the benefits without impeding the fast-moving culture that gives us an advantage.

So, why do we need a Comp Plan?

Provides a shorthand to refer to positions inferring relative compensation with enough meaning for discussions.

Allows your board to approve a hiring plan, thus executing their fiduciary duty, without necessarily approving each hire individually (this will drive you crazy if you have to do this and your board is negligent if they don’t approve your hiring in a responsible fashion).

Supports the need for a quantifiable company goal.

Standardizes benefits and limits intra-company pay inequality.

The next point in our Comp Plans is incentive compensation. Every person in the organization needs three temporal-based types of incentive comp: long term (stock options), intermediate term (annual bonus) and immediate term (immediate impact awards or spot awards).

First, when I say every person, I really mean everybody. Some companies limit options to the executive team. But that’s neglecting the huge impact that a modest grant can have on lower-level staff. It’s a mistake to exclude any full-timers. Everyone can and should have all three types of incentive comp.

Immediate impact awards are intended to fulfill a manager’s responsibility to “catch people doing things right” (credits to Keith Blanchard). The existence of a program makes it easier for managers to notice and reward staff and the presence of items to buy means there is accounting. And where there’s accounting, there’s reporting. Immediate Impact Awards help us with reporting tools for the CEO to know which managers are routinely rewarding their teams.

Bonuses don’t exist so that we can over-reward people with compensation that the market doesn’t require. Our concept of bonus is tied to pay at risk. If we need to compensate an engineer at $100k, we’ll offer him a base pay of $90k and, say, a 15% bonus. Now, if he and the company do essentially what they’re supposed to do, he’ll make a little more but if one or both fails, he’ll make less. His $10k is at risk. Junior staffers can still be part of this concept but with much smaller amounts at risk. When we pay bonuses, we allow them to pay over target amounts (we usually cap at 150% of target) for times when the individual and/or the company exceeded plan.

When we talk about performance, we have two factors: company and individual. Most of us understand individual assessments and the annual performance review process. One of our rules here is that performance reviews are done on an annual cycle, not on anniversary dates. It’s hard enough to get managers to produce these reviews when we have everyone in the company focused on it. They simply don’t happen (yes, we’ve tried) without an annual event and forcing function that company-wide publicity provides.

But how about that other component? The company’s performance is often overlooked or it’s sort of factored in after the fact with a board or management that decides bonuses need to be cut or not paid. Get proactive. Determine what the company’s quantifiable objective is for the year. This is a great opportunity for your massive whiteboard thermometer that you can update every week or month. It’s the goal that everyone sees in the breakroom. It’s the target that shows up at the top of everyone’s individual performance objectives.

These goals can be one thing (say, revenue) or several. The target can be quantified as stated or it can be something qualitative (like release v 2.0 by October 1) that become quantitative.

Microgreen Polymers used three items, each weighted 1/3 in their first Company Performance Factor (CPF): revenue; margins; and operating expenses. The board approved the targets and we measured against them monthly and drilled down on each at weekly management meetings. The CPF provided a great vehicle to unite the shop floor working with the Chairman of the Board.

With regard to stock options, most firms issue them at time of hire but they lack any strategy for issuances after that. If we assume that the company’s benefit of issuing stock options is employee retention then we need to appreciate the need for follow-on options.

Initial options will usually vest over four years with a 12-month cliff (since the average startup will take five years to exit, I’m a fan over longer exercise periods). The number of shares that vest per month looks like the blue area here. You can see that an employee in his third year has little additional vesting in front of him. To the extent that future vesting is a motivator (we wouldn’t have issued the options if we didn’t believe that was true), that motivation has diminished and may have little meaning.

If we embrace the reality of a longer term to exit and the need to keep employees motivated with a train of future vesting (see our notes on the evils of acceleration elsewhere), we should establish a program for annual re-charging of options at diminished levels to provide for a long-term flow of vesting. Such a program usually allows for smaller initial options with follow-on options at around ¼ of the initial grant. The amount of follow-on options then varies based on company dilution and company and individual performance. It’s the existence of the program that is important – the details of the follow-on amounts will change with the circumstances.

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It’s mid-October and there’s been a good deal of traffic regarding the market and its impact on venture-backed companies. Several of these pieces have received broad distribution and have trickled down, perhaps to unintended and inappropriate recipients. I think they’ve exacerbated the warranted alarm brought on by the public markets.

Early-stage companies operating on or raising rounds under $1MM will find their circumstances different than venture-backed firms or late stage companies. Even if the VC only invested $500k, such companies find themselves in a different scenario than an angel-backed one. These notes are for angel-backed companies.

(smart) Investors are going to look for deals with traction. If you can’t demo your product, go get a job or go back to school. The competition for angel dollars is going to be too tight for you this year. If you can sell your product, then sell. You’ll find more success in selling product than selling shares this year 1.

There are three important time frames to consider.

First, market stability. This chart shows the Dow over the past month. In addition to noting the crap-your-pants decline, see the intra-day moves – 500 points nearly every day over the past few weeks. Angels2 aren’t going to invest right now. Unless you’re in the final stages of collecting someone’s check, wait this out until we get some stability. If you’ve begun the funding process and cannot wait until next year, at least wait for stability. If you’ve got some good news that you expect will keep angels interested, keep those bullets in the gun – firing emails now will do you no good.

Second, Inauguration. The Economist ran an insightful article comparing today’s crash to the depression and, while there certainly are dissimilarities, an interesting point was made with regard to a lame duck president residing over such a crisis. Herbert Hoover did little to aid the economy in his final months and whether you’re a republican (like this author) or not, you’ve got to admit that our C-student, my-way-or-the-highway, crony-appointing president has a bad case of senioritis and will be of little help while appointed bureaucrats are left to mix things up with congress to develop a solution. Regardless of who wins in November, a leader will emerge in January to fill an important void. Absent more macro-economic news (I’ll stick to what I know), fund raising will be far easier next year. Do all you can to put off your efforts until then. If you’ve not begun, don’t.

Third, recovery. Cycles such as this are long and the consensus of economists rules out a V-shaped (quick) recovery. Good times are over for more than a few months. It’ll be years, most likely, and you can’t wait that long. So, make your deal as fundable as you can, take your lumps on valuation and get out there in Q1.

Early-stage CEOs are forever in fund-raising mode. But this is different and how you spend the next few months will depend on your situation. I believe that most start-up CEOs shift their mindset from “business plan” to “business” later than they should. Laggards will be particularly penalized this fall.

Once your product is selling, focus on execution.

Now, back to CEOs who are forever fund raising. Now’s the time to think about smaller rounds. Valuations might be a bit lower (arguing for smaller rounds to limit dilution) but the material factor is increasing the odds that you’ll close your round. Smart investors are going to worry about the source of the next check. Million-dollar angel raises used to be fairly straight-forward but they’ll be harder to close now. Push down your total target, accomplish key objectives (like a product launch, closing key accounts, or even break-even) then plan on going back out (yes, without much of a break). More than ever, embrace the reality that valuation grows in a step function and that smaller rounds are easier to close.

If you produce quarterly shareholder reports (you should), don’t stop now. You’re going to need your investors and there is a direct relationship between the frequency and quality of information provided to angels and their likelihood of making a follow-on investment.

You’re already scrappy so I’m not going to suggest that take a look at G&A costs. But it’s time to consider reducing costs where you may have some opportunity.

If your product is selling and you don’t have customer orders pending feature release (that’s to say sales are not dependent on dev work), then cease incremental spend on product development. This means killing your outside dev work and new hires. Now is the time to lay off any B or C players on the dev team. Sell what you have. Build v2 another day.

If purchasing has slowed in your market, consider cutting marketing spend since messaging to an audience that isn’t buying won’t bring benefit. I like to think that sales, however, can still be impactful but I’m a believer that a good salesperson can always get the job done – it’ll just take longer.

If you’re in hunker mode, then you need hunker-mode support and leadership. This means a reliable budget and CEO who can work your biz dev deals. If you have a CEO who you brought in to bag that $5MM venture round that you can’t pursue now then you have an unnecessary (and costly) resource.
As to the recent press, much of it fits venture-backed firms and some of it misses the mark as today’s problems are different from those in 2000.

One-size fits-all advice won’t work. Every company is different due to its technology, market, stage of development and, importantly, its status of fundraising efforts when October started.

My fellow angel Ron Conway re-sent his 2000 email recently (reprinted below). The 2000 downturn was led by inflated tech valuations. This one isn’t. Valuations never fully recovered from the late ‘90s and they shouldn’t have. Valuations don’t have nearly as far to fall now. If you were going to price your Series A at $2.5MM, maybe it’s now $2MM but, remember, when Ron first sent this note, a deal like yours was priced at $5MM.

If you weren’t pitching a start-up eight years ago (I wish I could forget) then you might mis-interpret Ron’s comments. It’s simply a different story today.

Otherwise, my favorite three words remain: take the money. Ron’s thoughts on raising more, faster, and from any source has always been our standard and, I believe, one of the reasons for our success. Set your targets low and over-subscribe if you find you have that option.

The other posts from Sequoia and Benchmark and others focus on cost cutting, getting scrappy conserving cash. Good advice for us all but, as I’ve noted, you’re already scrappy if you’re angel-backed on under $1MM.

These fright-driven messages can be misdirected if poorly timed relative to your company’s development, or can fail to take into account the mindset and market situation of your business. I just spent a few hours with one of our portfolio companies that is three weeks into executing a plan to sell our product with an inside sales team. The early returns are good and the team might pay for itself in the second or third month. But it’s just too soon to know, we need about a month. Panic-laden board calls now are just not helpful. We have a plan, it seems to be working, the company will reach break-even if it does and we need a month to evaluate it. Sometimes the plan is simple, not ambitious, and robust to most market conditions – we’ll see in this case. But we’ll see in a month, not now.

The other reason these messages can be misdirected (not, by the way, by the authors, but by those who forward them precipitously) is due to the mindset and situation of the company. The Sequoia deck (which I’ve received no fewer than eight times in the last 24 hours) is spot on for someone sitting on a few million dollars and executing the “Go Big or Go Home” strategy. It really is. Our world is different. Of our 42 portfolio companies, nearly all are seed stage and have been focused on achieving key milestones like first revenues or product release. A few of the lucky ones have been driving toward break-even. We can’t bankroll Go Big or Go Home so our companies just don’t have to make the same changes (such deals have to make other changes, not necessarily harder or easier – just different).

Angels have not gone away, we are going into hiding for at least a few weeks. Business will go on, deals will be funded3. Put away your pitch deck for the rest of the year if you can. Spend all your time with your pipeline, budget, and dev timeline. If you can get through the rest of this year, you’ll be ready to (hopefully) take advantage of a less-sucky Q1.

2 With notable (and enviable) exceptions like my friend Harvey who “went to cash and Tbills in June 2007 because (his) analysis of the irresponsible bank lending and securitization of synthetic/structured mortgage securities alarmed (him)”. Good for you, Harve!

3 Absent more public-market terror.

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Do I need to tell you about the importance of financial planning? Sheeesh, I hope not. Without a reasonable outlook, you don’t know how much money to raise now or when to start working on the next round or when to begin recruiting for needed positions.

Time Horizon

There are two time horizons of financial planning and a tool for each. The near term is this year. We define this loosely. If we’re more than, say, six months into the year, then we’ll look up to 18 months in the future to the end of the next calendar year; otherwise, we consider the current calendar year.
The extended term is five years – the range for which most investors expect you to project pro-forma results.

To manage near term operations, we develop a budget. Finplans suit the extended term.

But why the difference and why can’t I just have one document? Well, you could and we’ve tried.

Purposes of Budgets and Finplans

Budgets answer these questions:

Will I be able to make payroll next month?

How much more do I need to raise to keep the company going though our beta release in six months?

Should I be recruiting for any new positions now in order to have staff on board the plan calls for them?

Is it prudent to put this $100k over-subscription of our round into marketing?

Do I need to adjust some discretionary spend in the coming months due to recent performance (considered at a department level in more advanced companies)?

Budgets change when the sales pipeline suggests it (sadly, too often by a need to reduce spend). These changes nearly always impact two things: moving hire dates and reducing discretionary spend in marketing and travel. Updates typically occur no more frequently than monthly and more mature (post-series B) start-ups might expect an update once or twice a year.

Finplans answer strategic questions and go through many iterations. Once frozen, a finplan is typically used for a funding round or strategic planning and then shelved until updated for the next funding round.

It is the nature of these changes and purposes that leads us to two documents:

Level of Detail

Budgets must be prepared at a line-item level, using the company’s chart of accounts. This is needed for budget v actual reports. We issue these to develop “responsibility accounting” whereby department heads can become responsible for their group. These reports are required if a CEO is going to delegate any budget responsibility or spend authority.

Line item level of detail is needed to plan exact costs such as rent, which grows (or shrinks) as a step function. The budget will show us exactly when the company plans to move and by how much rent will increase at that time. Your budget should facilitate easy changes to hire dates and discretionary spending. It should clearly identify what you’re planning on buying.

The above budget detail forces the user to think tactically about his marketing plan. This pays off when it comes time for execution. Also, if adjustments are needed, the user will think about cuts at meaningful level, not just arbitrary reductions or additions.

The above level of detail… well, do I have to say any more?

Change, nothin’ stays the same

(Van Halen)

The frequency and nature of updates is a key driver for the development of these parallel financial tools. Finplans support events (typically fundraising) while budgets support on-going operations. The life of a finplan is measured in weeks, after which it’s shelved to be updated for the next event. These are intense weeks likely to result in radical changes in company fundamentals, from selling a product to selling a service or releasing a consumer version or all matter of fundamental alterations to the company’s core business. A robust finplan will deal with these and provide a P&L, Balance Sheet and Statement of Cash Flows (bonus points if they reconcile to one another!) with relative ease. While you’re debating the merits and examining the impact of creating a professional version of your turnip dicer to sell to restaurant supply houses, you need to be able to focus on these changes without the distraction of cost details.

So, your finplan should not be built with a charts of accounts. Instead, it should use broad cost categories like Equipment, Travel, and Facilities. These cost categories should be populated with formulas rather than amounts – formulas like $800 per head for facilities and $2k per sales head for travel. Formulas such as these allow for a single input that scales (more or less) as you consider different strategies. Of course, staffing must be forecasted at far deeper level of detail and, if your business is capital intense, then that too.

By ignoring step-functions or other detailed cost-drivers for minor costs, these formulas ensure that costs are approximately correct on an annual basis while avoiding the potential that they may have been forescast completely wrong (because committing to more detail inevitably results in user error) and they result in a tool that fully meets the objectives of a finplan.

Using formula-driven costs for most of your categories allows you to focus on the strategic changes that matter.

When to Update

Oddly enough, this question is still a source of debate in board rooms and at exec team meetings. The answer is different for each tool.

Given the purpose of a budget, there’s no point in continuing to look at a budget once you have better information. Change it. “But the board wants to continue to see performance measured against the approved plan”. Ok, here’s two answers:

Why? To see that management is or isn’t good at forecasting for a new company selling a new product to an emerging market? What’s the point? Really – what will we do differently if we find that we’re budgeting well or not? Only reality matters.

Ok, we’ll show two reports – actual v. approved plan (which is frozen) and actual v budget (which reflects the most current information).

The finplan is a little different. Once the team settles on a direction, freeze the finplan, write your business plan and move on. If you decide that you need to change direction, well, you weren’t done. But once you are, don’t go back to tweak your finplan. You’re not going to hit those numbers anyway (not saying you’ll be high or low, just that you’d effectively need a crystal ball to forecast a start-up’s revenues five years out), so don’t worry about editing because you feel you need to make a 10% adjustment.

CY or FY

Every now and then someone wants to use a planning year other than calendar year. This decision commits you to a great deal of hidden costs. Every time someone says a year (“I’m going to need another dev in 2011”), they’ll be countered with: “is that fiscal year or calendar year”. I swear to God this will never become natural. Sometimes you have to bite the bullet. Maybe your primary customer is the federal government or your product is sold to retail with strong seasonality that doesn’t fit the calendar. Otherwise, avoid using anything other than the calendar.

Deals that will beat LinkedIn, Facebook, Twitter, or Google because they charge the model.

Deal that would beat eBay because listings were free but they charged the buyer.

The incumbent probably considered your model. They may have tested it. They have more resources and better market intelligence and they’ll copy if its better.

Even so, an improved model won’t generally be enough to attract the millions of users you need.

3. Following the herd (web 2.0 – in contrast, Second Ave’s win with a drone, our wins with CEC, Expertcity, RVM. Big wins are either early in a trend (early dot-com etailers, early social networks) or are just different).

2. Failure to understand the market

You’re not the market and even if you’re typical, you’re only a data point.

Get out and sell, pre-sell, and don’t just talk to your mom.

1. Listen, really listen to the critics. Like the bunny says: It’s not them, it’s you. Don’t brush them off.

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First, let’s get one thing clear. You’re here to build and operate a business – not to build and deliver an investor pitch.

Alas, the latter is a requirement unless you’re willing to tap that pile of gold doubloons in your basement to get your company off the ground. At Atlas, we see 5-10 formal presentations to our partner group each month. As a partner in the firm, I take 1:1s with one or two new entrepreneurs each week. And as a member of angel groups and on their screening committees, I see another ten or so monthly. After more than a decade, I’ve seen nearly 3,000 investor pitches (now that I’ve done that math I’d dearly like to get back some of those 15-minute blocks of time!).

Everyone has an opinion on investor pitches. Everyone. When you get input (and seeking input builds a foundation for a good pitch), listen to people with large data sets. Listen to people who write checks. Don’t put much faith in one or two-time entrepreneurs (those who have only once or twice shared your current opportunity and need). Don’t fret over advice from angels who have only made a few investments. Most importantly, appreciate that everyone has an opinion on the subject and these opinions will conflict. When credible reviewers give conflicting advice, sort out the rules from the opinions (this has to do with the strength of the input. I, for one, try to tell someone when I’m sure they must follow my input because it’s a rule based from many observations versus times I offer my opinion but without great conviction).

First, let’s talk content. Linden Rhodes, a successful angel investor once told me that a pitch has to simply state “how it’s done now, what changes with your product or service, and why that’s better”. I’ve used this several times – it makes sense and it covers the basics that are often overlooked.
You need to cover these areas:

Product or service. What do you do? Fail to make this clear and all the laser pointers in the world won’t help you. Here’s a template of what to say:

Business model. Explain how you provide your product or service and how you sell it.

Market and size. Be practical on your target market in terms of breadth (e.g. you’ll sell to the shipping departments of manufacturers, not to all companies of any type) and target size (e.g. you’ll sell to companies shipping 500 to 200,000 packages a month, not to everyone) as well as geography (we almost always suggest that your initial customers will be domestic). The chart here shows the market size for ThinGap motors at the time of their initial pitch.

Competition. Cover all your competitors but feel free to use groups.

Development timeline. When will this thing be ready for sale? It’s important to tell people the stage of development – are you still building the first version, are you in beta, do you have paying customers?

Team.

Financial projections. The minimum is a five year P&L.

The ask. This is your second-to-last slide. What are you selling? What is the pre-money valuation (if equity) and what are the basic terms.

That’s the core for content. These are the absolutes of your pitch:

It’s not the leave-behind. Your pitch deck is not a stand-alone document. That document is called your business plan. Don’t write your pitch thinking you’re going to email it to someone and they’re going to comprehend it. Write your business plan that way. Apologies to Microsoft (where they communicate by sending powerpoints), but this is just stupid – please stop it and spend your time making it easier to paste Excel output into Word.

Your pitch is a part of a multi-modal presentation – you’re the audio. The powerpoint is the video. You say words, the powerpoint should provide images – pictures, graphs, tables. It should not contain just words.

Find out how long you have for your presentation and build a powerpoint deck to suit the time frame. Different audiences have different time requirements; you’ll likely end up with 7, 10, and 15-minute versions.

Reading from the slides is a misdemeanor in most states. If you do, you’re required to return this book to place of purchase. No refund will be offered.• Great presentations use great graphics. You will deliver a finite number of key points, about one per slide. What image best reinforces that point you want to make? Here’s a great example from the Coffee Equipment Company. While the audience saw these two slides, the CEO asked (extra points for engaging them) who drank wine. Then he asked: “when you order wine, you do just say “wine, please”, or do you order a pinot noir or maybe a pinot noir from Santa Ynez? Our equipment is a vital part of the movement to allow consumers to have choice in coffee and sales at coffee shops show us they want that choice.”

Here’s another solid one. The CEO at Escapia was communicating the company’s opportunity to help vacation rental property managers book more revenue by increasing occupancy rates. This is the slide the audience saw while the CEO said: “we’re all familiar with discounts and promotions at hotels. Hotels use these sales tools to increase their occupancy rates. Vacation rentals are unable to offer discounts unless the property manager is an Escapia customer. By enabling discounts, we can increase the property manager’s bottom line.”

If you have an opportunity to interact with a slide, so do. Maybe you have a timeline that shows your planned product roadmap or a picture of your proprietary production machine. Point to it and take the audience through the picture and tell the story.

You may need words on a slide to provide detail. Lists help to reinforce depth. Listing your customers while you say how many customers you have and what market segments you have penetrated will provide a visual that adds credibility. The audience will remember (“did you see that long customer list, they must be on to something!”).

You get one slide for your team. Pick a format and put everyone in that format. I like to see name, title, age, experience, and education. You’ll have to abbreviate here. Save the audience from reading “great team with deep experience” and you’ll be the only guy who did so. Instead, just put the data on the slide and tell a story. How did the team come together? Why did they join? The best pitches I’ve seen use this slide to make us laugh with some story about how the founders cooked up this idea or how they recruited the key engineer.

Slides have to be readable from a distance. A good friend told me about the rule that font size can’t be less that ½ of the age of the oldest person in the room. Well, that’s not quite it but you get the idea.

Every word has a cost. Every word on a slide takes the audience’s attention. Ruthlessly remove words from each slide. Keep reviewing and removing until it’s bare. Remember, you’re the words, the powerpoint is the image.

Include a summary of your financials. We like this format with revenue, gross profit, and net income before tax. If gross margins don’t matter, don’t show them. But everyone wants to see the top line and the bottom line. Sometimes, the number of customers or some other non-financial metric is vital. A chart with two vertical axis can work – just keep it clean.

You’ll almost always need a competitive matrix slide. Make it clean and easy to read like this one. Use red, yellow, green or filled, half-filled, empty circles or smiley, neutral, frowning faces (no, seriously, I’ve seen this) to make it easy to read. Don’t use text; it takes too much attention to comprehend.

Include a summary of your product roadmap. There are many ways to do this but timelines are the easiest. When you talk to this slide, show the audience your logic for the releases you have planned.

Kill the “thank you” slide! The last slide is the most important one – it will be on screen during discussion or Q&A. That’s often 10 to 100 times as long as any other slide. Whatever your summary or most important point is – put it on the last slide. It should not say “thank you” or just have your name and address. You might show a summary of “why invest” or maybe a chart of your historical revenues or picture that summarizes the value of your invention. Put this slide up and say: “thank you, I’d like to answer your questions”. For the final slide for Microgreen Technology, we chose to have a slide that showed the technology. This slide stayed up for ten minutes during the Q&A part of our presentation to angel groups.

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If you’re launching a web service for consumers, you have an important decision to make: how will you take your web application to market? You have a pricing decision to make and trying to grow your user base by selling at list price probably won’t work. Most successful launches involved products that are free for initial users.

Of course, free for initial users doesn’t mean free forever for everyone. Typically, Freemium refers to products that have two (or more) versions with the lowest functionality free to users. Think of AVG anti-virus or Adobe’s PDF. Premium refers to products that are sold at all levels but usually (and probably should be!) are offered with a free trial period (like many enterprise software products).

Your decision regarding Freemuim vs Premium is based on these factors:

Support requirements

Serving costs

Go to market method

Migration potential

Let’s be clear that this is a decision regarding shades of grey in many cases – it’s not easy but the above factors will provide a framework to think about it.

Support Requirements. Freemium models usually grow more quickly at first (free forever has a lot of appeal). If you think this will be the case with your offering, consider the amount of support you need to give to users. Some applications require customer support or labor to set up accounts. A Premium model can offer more controlled growth to ensure a good user experience as you grow your user base. And don’t think the community is going to provide support; certainly not initially. You don’t have a community yet and one will never grow unless there’s initial support.

Serving Costs. To have gross profits on a Freemium model, you’ll need solid adoption to the up-sale versions and/or advertising revenue. While your product could break the trend, about ½ – 3% of consumers typically upgrade from a Freemium product. If you’re selling other products (think of free photo sharing sites selling prints and coffee mugs), adoption can be slightly higher but likely won’t exceed 5% in any event. If your serving costs are high, you may not be able to afford all those free users and you may need a Premium model to ensure positive margins.

Go To Market Method. Growing your user base for a Fremium product requires building a consumer brand. There are limited options for partnering or boosting the initial user base outside of marketing. Successful launches depend on viral growth. This strategy is always scary to me – it you build it, they will come. A Premium product has a look and feel that’s more suited for traditional sales methods – channel sales, even inside sales. This is because you’re, well, selling (not giving something away). Implementing a Premium strategy means you can force-feed the user base to get it going. If the product has a viral growth opportunity, then you should be able to see it grow that way (you may need to change to Freemium for it to grow quickly).

Migration Potential. Let’s assume your crystal ball will have a bad day when you make this decision and you need to change your mind. Moving from Freemium to Premium will require breaking a promise to your users (the promise that the product will always be free at its base level). You can only do this in the very early stages of growth and, even then, it could be quite costly to your reputation. If in doubt, launch with a Premium model because changing from that launch point is more palatable.

It might sound like I’m advocating launching your product with a free trail period instead of a free version. I’m not. This is a complex decision that every company must deal with differently – I believe this framework will allow you to make that decision.